“Numismatists believe that the earliest coins were produced at Lydia (now Western Turkey) in the mid-seventh century BC. The coins were made of electrum, a naturally occurring alloy of gold and silver. They had a design on one side and were of uniform weight but had a highly variable proportion of gold. In an influential article Cook (1958) argued that these coins were introduced to pay mercenaries, a thesis modified by Kraay (1964) who suggested that governments minted coins to pay mercenaries only in order to create a medium for the payment of taxes …”

One can also read the interesting review article by Peacock (2006), who concludes:

“the state’s role in the development of coinage is undisputed … Coinage was not an endogenous development of the economic sphere, as Menger held, nor was it created merely in order to facilitate trade which had existed thousands of years before money and was in no need of facilitation” (Peacock 2006: 642).

The reason that coinage became a widely-accepted medium of exchange and unit of account was that the state demanded its issued coin back for payment of taxes and other payments to the state, such as harbour dues and fines. This process is what monetized the economy and encouraged the use of coinage as a medium of exchange.

“The simple fact of the matter is that, despite talk of austerity, the UK government continues upon its binge of borrowing and spending …. The UK economy is still sitting upon the life support of government borrowing, and has yet to face what might happen when the borrowing stops, and repayment starts. Even with the linked inflation and currency devaluation, the UK debt position remains in a dire position.”

In reality, the UK government-debt-to-GDP ratio is about the middle of the range and (for the UK) not historically that large:

Both Germany (at 83.20%) and France (at 81.70%) have worse government-debt-to-GDP ratios, yet the sky is not falling in those nations.

The fact that government borrowing has continued and the government-debt-to-GDP ratio has risen under the Tories is not even remotely surprising. Why? First, the real effects of austerity are only kicking in this year, and, secondly, there is already ample evidence that, without truly extreme cuts, austerity causes the budget deficit to get worse, as economic activity and tax revenues plunge, and more people become unemployed and claim social security from the state.

Take a look at Ireland. Ireland rejected Keynesian stimulus, and implemented austerity early. The result? By 2009, it already had the biggest budget deficit in Europe in terms of the percentage of its GDP. The country suffered a depression and the government-debt-to-GDP ratio is now 123.80%. Stunning proof of the success of this type of austerity?

The apologists for austerity will perhaps complain that the cuts weren’t deep enough. To really cut government spending and debt the austerity has to be so brutal that the country is plunged into severe depression and people are driven overseas. This is what has happened in Latvia:

“Neoliberal austerity [sc. in Latvia] has created demographic losses exceeding Stalin’s deportations back in the 1940s (although without the latter’s loss of life). As government cutbacks in education, healthcare and other basic social infrastructure threaten to undercut long-term development, young people are emigrating to better their lives rather than suffer in an economy without jobs. More than 12% of the overall population (and a much larger percentage of its labour force) now works abroad. Children (what few of them there are as marriage and birth rates drop) have been left orphaned behind, prompting demographers to wonder how this small country can survive. So unless other debt-strapped European economies with populations far exceeding Latvia’s 2.3 million people can find foreign labour markets to accept their workers unemployed under the new financial austerity, this exit option will not be available.”Michael Hudson and Jeffrey Sommers, “Latvia provides no magic solution for indebted economies,” Guardian, 20 December 2010.

Perhaps there are some who want to claim that this is actually a vindication of their approach to economics.

Fortunately, the economic theory behind austerity of any type is deeply flawed, and an alternative is available to us: Post Keynesian economics.

(1) “I argue that within the coordination framework of the market — which finds its basis in the fact that individuals are constantly arranging and re-arranging a palette of means amongst chosen ends — the notion of ‘idle resources’ is ludicrous.”

Catalán might care to acknowledge that even some Austrians reject the notion of plan/pattern coordination in free markets, so even his own economic school is divided on that issue.

Anyone who rejects the belief that the free market has a coordination mechanism will see that there is bound to be a waste of resources and involuntary unemployment in such a system. It is the denial of the reality of “idle resources” that is ludicrous.

(2) “He then goes on to say that I would probably respond with something about morality. Well, if you’ve read anything on morality that I’ve written, I actually reject the concept of natural rights. So, we can effectively ignore that part of Lord Keynes’s post.”

The problem of involuntary unemployment has severe human costs. This weak attempt at evasion does not answer my question. A rule utilitarian or Kantian might contend that the human cost of high and long-term involuntary unemployment is unacceptable, and that government intervention is required.

How can Catalán respond to that? As I have said before, all he can do is get drawn into a debate on ethics.

Does Catalán:

(1) Think there is a convincing objective theory of ethics, and

(2) What theory does he support?

The issue cuts right to questions about philosophy of ethics. If two people (an Austrian and Keynesian, say) wanted to seriously debate, they would have to ask:

(1) Is there an objective theory of ethics?

If one person does not believe in objective ethics, then the debate is already over: it would become an argument about whether ethics is objective or subjective. Also, anyone who believes that morality is subjective can just appeal to David Gauthier's Morals by Agreement and come up with some contractarian theory in which, if a majority of people assent to living by certain rules, then this is perfectly defensible ethics.

If one takes David Gauthier’s Morals by Agreement as a method for ethics, then modern social democratic states already have a majority that supports basic principles like progressive taxation, so it appears to have ample justification.

(2) If both people agree that ethics is objective, then what ethical system is true?

Our morality cannot be justified by an appeal to nature: that is why most natural rights/natural law based ethics collapse, and why natural rights ethics in the Rothbardian or Randian tradition won’t fly. Catalán says he rejects natural rights ethics. What theory does he support?

(3) “I do think labor markets can clear, and I do think that government legislation introduces a lot of price rigidity in labor markets that would otherwise not exist (for example, minimum wage, labor laws, et cetera). I don’t agree with John Keynes (the dead one, not the blogger) that in a free market downward price movements would face resistance from workers, and I think that there is plenty of empirical evidence that disproves this particular facet of Keynes’s argument (note the relative speed at which wages fell in the early 1930s, as compared to the rigidity faced between 1929–1931, for example).”

Catalán is bizarrely unaware of the empirical evidence against him. The problem of wage stickiness is a well known one in modern economics. Workers object to having their nominal wages cut. Even managers often dislike across-the-board pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity. Catalán can read T. F. Bewley,Why Wages Don’t Fall During a Recession (Cambridge, MA., 1999) for a good empirical study of this phenomenon.

The economic theory that drastic cuts in wages will be able to cure depressions quickly (a feature of neoclassical economics and the Austrian school) is simply a fantasy that takes no account of the empirical evidence from the real world. As I have also said above, yet another impediment to this belief that markets will clear is that Say’s law is a myth.

(4) “The market enjoys a mechanism which has been developed through the division of labor that tends to distribute wealth to those who best serve the consumer — I cover this in an article published before ‘Government Spending is Bad Economics’. Bad entrepreneurs suffer losses, good entrepreneurs make profits.”

Capitalism has markets for commodities and financial/real assets. Money as a store of value, liquidity preference, and these financial markets are a spanner in the works that destroy this fantasy view of capitalism. A great deal of wealth is not used to “serve the consumer” – it is wealth tied up on secondary markets for financial assets or real assets. Capitalism does not necessarily “distribute wealth to those who best serve the consumer.” Real world capitalism - where it exists without effective financial regulation - is plagued by asset bubbles, financial crises, and debt deflationary collapses that come about when these asset bubbles burst. Capitalism in the 19th century was regularly hit by crises of this type. We managed largely to eliminate this type of business cycle after decent financial regulation was introduced in many countries in the 1930s and 1940s, until it was attacked in 1980s and 1990s under the influence of the New Classical macroeconomics. The result was severe asset bubbles in the 1990s and 2000s, and the financial crisis of 2008, and the debt deflation many nations are now experiencing.

Subjective expectations in the investment decision can destroy business confidence for years, in an environment of fundamental uncertainty.

One Austrian response to this is to construct a mythical, totally unreal version of what they think capitalism should be like - one that has never existed in the real world. Some Austrians think that fractional reserve banking (FRB) must be abolished, since they blame it for asset bubbles and the business cycle. They are right that FRB can be inherently unstable and contribute to the business cycle.

But anti-FRB Austrians such as Murray Rothbard hold a position that is incoherent and would require restriction of free contract and private enterprise, so in fact such Austrians - by their own demand for pure laissez faire – demand an “evil”, collectivist, anti-freedom ideology requiring limits on private liberty. The pro-FRB Austrians are in fact the only ones who really do have a logically consistent argument for free markets, economic freedom, and free contract.

Fractional reserve banking is an invention of the free market and has been a fundamental part of capitalism for over two centuries. By demanding its abolition and admitting it can cause severe problems, anti-FRB Austrians have effectively refuted the idea that the unhampered market is the best system possible, and have inadvertently waved the white flag of surrender.

(1) “The continuous process of allocating resources throughout society is simply an aggregate of the ongoing calculation that takes place on an individual basis. These individual actions coordinate on a macroeconomic scale through the pricing process and through the division of labor. Producers are rewarded or punished through profit and loss, creating a tendency for capital to flow to those who use it the best (those who satisfy the consumer the most). This is the market method of rewarding ‘efficiency.’”

This is part of Catalán’s defence of the idea that the free market has a coordination mechanism. Yet again one sees the flawed inability to understand the role of non-neutral money, money as a store of value, financial asset markets, private debt, debt deflation, and subjective expectations.

What happens when capital flows into asset speculation? When the economy is saturated with private debt? When asset bubbles burst and debt deflation happens? When business confidence is shattered? When the economy is hit by what Hayek later called secondary deflation?

(2) “It is worth mentioning that governments tend to exacerbate the degree to which resources are left ‘idle’; thus, one could make the argument that the problem of idleness is to a large extent artificial. However, this would imply that there could nonetheless be some degree of idleness on the market and that this presents some type of problem. The correct answer to this question is the one that explains why the supposed problem of ‘idle resources’ is actually not a problem at all, because resources are not purposelessly left idle. Economic goods are constantly economized within the means-end framework of the individual market agent. That some goods may not be applied toward the attainment of a specific end does not mean that these resources are now idle and valueless. It simply suggests that these resources are better saved for the attainment of another end.”

And what end would that be? In conditions of recession, depression or high involuntary employment and unused capacity, it is precisely that the private sector is not employing them for any end that makes them idle! There is a classic non sequitur.

(3) “One can reasonably expect an increase in the quantity of ‘idle resources’ during periods succeeding phases of prolonged intertemporal discoordination. During the length of intertemporal discoordination, the structure of production grows around the distorted profit signals caused by monetary expansion.”

Most of the rest of Catalán’s section on “idle resources” requires Austrian business cycle theory (ABCT), a flawed and untenable theory of the business cycle. It follows that anyone who has good arguments against ABCT will have no reason to accept the arguments here.

For the sake of argument, let’s ask: does ABCT explain the recession of 2007–2009? The answer is: it certainly does no such thing. Therefore objections to fiscal policy based on ABCT are irrelevant.

“Let’s be very careful here, ‘Lord Keynes’. The market does have a coordination mechanism and I don’t think even Post Keynesians reject that. You have an effective demand schedule, do you not? You have a supply schedule, do you not? OK - you have market coordination. What you mean is that you don’t always have a clearing market or an optimizing market. But you do have coordination. Investments aren't made and prices aren’t set by throwing darts at a dart board. Prices coordinate.”

Fair enough. But it seems to me that Catalán was using “coordination mechanism” in sense of plan/pattern coordination in free markets.

But the issue still comes right back to whether Say’s law works, and whether there is a mechanism that causes free markets to result in full employment equilibrium and optimum use of resources. I think most my comments stand.

The trouble is that full employment/high employment “equilibrium” is a neoclassical, not an Austrian, concept.

Austrian economics, as far as I understand it, does not use the neoclassical concept of full employment “equilibrium.”

Instead, some Austrians invoke the concept of pattern/plan co-ordination (e.g., Hayek, Rizzo and O’Driscoll), while others would agree with me (e.g., Lachmann and other radical subjectivists) that there is no tendency to pattern/plan co-ordination or full employment “equilibrium” in a free market economy.

Because of uncertainty, subjective expectations, money as a store of value, financial asset markets, debt deflation, etc., Say’s law does not work, as I have shown here:

I would also recommend the classic essay by Ludwig Lachmann called “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society.” A sample:

“In a kaleidic society the equilibrating forces, operating slowly, especially where much of the capital equipment is durable and specific, are always overtaken by unexpected change before they have done their work, and the results of their operation disrupted before they can bear fruit. Restless asset markets, redistributing wealth every day by engendering capital gains and losses, are just one instance, though in a market economy an important one, of the forces of change thwarting the equilibrating forces. Equilibrium of the economic system as a whole will thus never be reached. Marshallian markets for individual goods may for a time find their respective equilibria. The economic system never does. What emerges from our reflections is an image of the market as a particular kind of process, a continuous process without beginning or end, propelled by the interaction between the forces of equilibrium and the forces of change. General equilibrium theory only knows interaction between the former.”
(L. M. Lachmann, 1976. “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society,” Journal of Economic Literature 14.1: pp. 60–1).

What Lachmann says here is much the same as what Keynes and Post Keynesians would say. The “plan coordination” imagined by Hayek and other Austrians will not occur under these conditions of uncertainty, subjective expectations, and money with a store of value function.

But Keynesians would draw a different conclusion from Lachmann: with no full employment equilibrium and optimum use of resources, there is a space for government intervention on both moral and economic grounds.

Tuesday, April 26, 2011

And for that matter: who cares if Krugman won the Nobel Prize in Economics?

Anyone who is serious about debating should know that appeals to authority are logical fallacies. I often see people appealing to the fact that Hayek got a Nobel prize, as if this should impress us, and as though it provides some support to his theories. This is nothing but an appeal to authority.

Here are some crucial points in response:

(1) The Nobel Memorial Prize in Economic Sciences is not even a proper Nobel prize at all: it was not set up by the will of Alfred Nobel in 1895. Instead, it was established by the Central Bank of Sweden in 1968.

(2) Friedrich Hayek won the prize in 1974 jointly with the Swedish social democrat Gunnar Myrdal.

(3) The overwhelming number of Nobel Memorial Prize in Economic Sciences winners are neoclassicals, neoclassical synthesis Keynesians or New Keynesian economists who reject Austrian economics, but

(4) It is neither here nor there if Hayek, Krugman or anyone else won the Nobel Memorial Prize in Economic Sciences. It doesn’t mean much.

Neoclassical economics is wrong and the majority of Nobel Memorial Prize winners are neoclassicals. It follows that most of these people’s theories are probably wrong too. Some Post Keynesians have been awarded the Nobel Memorial Prize, but again this does not give any extra support to Post Keynesian economic theory.

Post Keynesian economics – just like any other economic theory – will stand or fall on the truth of its foundational assumptions and the consistency and cogency of its arguments, and, where appropriate, whether empirical evidence gives support to its theories.

Monday, April 25, 2011

One of Catalan’s arguments is that idle resources are not a problem and there is no need for government use of those resources in recessions:

“Idle resources are means of production that are seemingly being left unused — an obvious example is an unemployed laborer. If these means of production are ‘idle’, what harm is there in government employing these resources? …. The correct answer to this question is the one that explains why the supposed problem of ‘idle resources’ is actually not a problem at all, because resources are not purposelessly left idle .... That some goods may not be applied toward the attainment of a specific end does not mean that these resources are now idle and valueless. It simply suggests that these resources are better saved for the attainment of another end.”

There you have it. All those unemployed people are “better saved for the attainment of another end.” It doesn’t matter one iota that these people want to work, that people don’t want to lose their houses, live on the street or under bridges because of financial hardship, or that the social and economic losses under high involuntary unemployment make society poorer.

This type of Austrian analysis falls flat on its face.

And those of us who reject the fable of natural rights/natural law arguments for anarcho-capitalism have ethical arguments justifying government intervention on moral grounds alone. Catalan could say very little in reply, except get drawn into a debate on moral theory.

Catalan’s conclusion contains a completely unsupported assertion:

“Government, in fact, is a large disequilibrating force on the market. It forcibly redistributes economic goods, removing them from a process of economization and instead investing them toward the realization of less important, or less preferred, ends.”

How would he know that a democratically-elected government’s spending program does not reflect the important, preferred goals and wants of the community? If the majority of people have voted for such a program, then clearly these are ends that command wide support. If, say, a fiscal program is supported by 55% or 60% of the community, then it is a realization of the important and preferred goals of a majority of people.

Sunday, April 24, 2011

The most serious blow to the world economic system after 1973 was the dismantling of the post-WWII Keynesian system that gave us the golden age of capitalism (1945–1973). This attack on the post-war consensus in economics occurred in the 1970s and 1980s when monetarism, New Classical economics, and then the New Consensus Macroeconomics came to dominate the economics profession and public policy. Of course, conservatives like Reagan and Thatcher were leaders in that neoclassical assault. The post-1979 era has been one of neoliberalism, globalization and neoclassical economics. And look how that era has ended: with world-wide financial meltdown and the globe on the verge of depression. Keynesianism pulled us back from the brink.

By contrast, the previous post-WWII economic system was that of the mixed economy with financial regulation, Keynesian macroeconomic management, and even nationalized industries in some countries. Certain versions of the mixed economy – particularly those in social democratic countries in Europe – have probably been the most successful, efficient and humane economic systems humankind has ever devised, systems that have increased wealth tremendously by delivering high employment and maximal use of resources.

Now don’t get me wrong. Perhaps there are better systems – maybe our descendants will be clever enough to discover even more successful ways of managing economies.

But one can only note that the demand that modern governments should return to the tried and tested Keynesian system we once had isn’t a particularly “radical” proposal.

One central proposition of conservatism is the idea that we should favour historically successful ways of organising society – methods that are tried and tested – rather than radical and untested systems and policies. While I am not always convinced by this maxim, and I do not regard myself as a conservative, a return to a Keynesian system and effective financial regulation could actually be constructed and defended as a conservative policy.

I wonder what has become of the old-style conservatives with a social conscience who had no fanatical devotion to free market economics. In fact, mainstream conservatives after World War II largely accepted the Keynesian consensus (for how they did in the US, see “Keynesianism in America in the 1940s and 1950s”).

After all, why should conservatives necessarily be committed to laissez faire? Conservatives began in the 19th century as the enemies of Classical liberals, the historical proponents of extreme free market economics.

For example, one can point to various types of British Toryism that have been critical of extreme capitalism. The early factory system and its cruelty were attacked by Tory radicals and Tory paternalists of the early 19th century who had a marked anti-capitalist ideology, and they even helped to introduce legislation reforming working conditions in UK factories.

Under Thatcher, the Tories were divided over battles between the “Wets” and “Dries.” The former being old-style conservatives like Sir Ian Gilmour and Jim Prior who opposed Thatcher’s monetarism and more extreme free market ideology (Evans 1997: 45).

In regard to Gilmour, I can only say: whatever happened to this type of Tory? I quote from his Guardian obituary:

“Ian Gilmour, the liberal Conservative politician, Lord Gilmour of Craigmillar, … died aged 81, served briefly as Edward Heath's defence secretary and for two years as lord privy seal under the less congenial leadership of Margaret Thatcher …. his reputation rests less upon his time in office than on his longer term opposition to Thatcher and Thatcherism. His background as proprietor (1954-67) and editor (1954-59) of the Spectator, and his books, made him a different kind of Tory. He was also one of the most consistent, and constructive opponents of Ricardian free market economics and their social consequences to be found in parliament. …. He first attracted attention with his purchase of the somnolent Spectator in 1954 .... Gilmour’s Spectator was humanitarian in social matters, anti-adventure in foreign affairs and Keynesian in economics. Edward Pearce, “Obituary: Lord Gilmour of Craigmillar,” Guardian, 24 September 2007.

The 21 April, 2011 marked the 65th anniversary of Keynes’ death. That is not a happy anniversary for me, as I regard Keynes as one of the greatest economists of all time, and his true legacy to be modern Post Keynesian economics, with Modern Monetary Theory/Chartalism firmly within the Post Keynesian family (though others might disagree with the latter assertion).

Keynes died of a heart attack on 21 April, 1946 at the age of 62, not long after his return from America. Keynes was survived by his wife Lydia Lopokova, a Russian ballerina, who actually lived until 1981. Keynes’ passing was a few years after he had attended the Bretton Woods conference in 1944, at which the world’s post-WWII international monetary system was organised. The International Monetary Fund (IMF) was one of the institutions that emerged from the transactions at Bretton Woods.

It is rather astonishing to see Strauss-Kahn making statements like this:

“At the end of his magnum opus, The General Theory, Keynes stated the following: “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes” ….

“Let me start with employment. Just as we managed to tame inflation in the 1980s, this decade should be the decade that takes full employment seriously once again ….

Collective bargaining rights are important, especially in an environment of stagnating real wages….”

All true, but I don’t expect a conversion to Keynesian truth at the IMF board any time soon, though there have of course been some promising changes at the IMF recently, not least of all the recognition that discretionary capital controls are now needed in developing and even some developed countries to control destructive short-term capital flows.

But the real test of whether Keynes is still relevant is what happened during the global financial crisis and world-wide recession in 2008–2009. Faced with the plunge into global depression, most governments returned to the tried and tested Keynesian medicine of fiscal stimulus. That policy worked well, but more stimulus was, and is now, required.

It is sad to note the anniversary of Keynes’ death, but his economics is alive and well, as is the struggle to return us to Keynesian full employment.

Rizzo takes up comments made by Ludwig Lachmann in “John Maynard Keynes: A View from an Austrian Window” (South African Journal of Economics 51 [1983]: 253–260):

“In the field of methodology Keynes and the Austrians agree that economics is a social science to which methods that have proved successful in the natural sciences should not be applied without careful inspection, and that, in particular, all attempts to ‘give numerical values’ to the parameters of economic models ignore the essential meaning of economic theory. It is hardly surprising that even here we find differences of accent and perspective, but, with the area of agreement so broad and significant, they do not amount to much ….

Keynes concurs with Hayek’s misgivings about numerical values. In his letter to Harrod of 16 July 1938 we read ‘In chemistry and physics and other natural sciences the object of experiment is to fill in the actual values of the various quantities and factors appearing in an equation or a formula; and the work when done is once and for all. In economics that is not the case, and to convert a model into a quantitative formula is to destroy its usefulness as an instrument of thought’ ….

But Keynes’s mind also moves in another direction. ‘I also want to emphasize strongly the point about economics being a moral science. I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth’ (ibid, p. 300). Keynes sees in social facts manifestations of the human mind. While to Hayek it is the complexity of these facts, their multitude and diversity, that defies the attribution of numerical values to social concepts, to Keynes it is their mental character (‘mistaken calculations on the part of the apple’) that does so. Rather to the surprise of some of us, Keynes emerges as being more deeply committed to subjectivism than is his Austrian opponent” (Lachmann 1983: 256).

It might come as a surprise to the various Austrian sympathizers (who think Austrian economics begins and ends with Mises and Rothbard) that their school includes the Lachmann wing and some of the moderate subjectivists who are able to appreciate Keynes, rather than engage in endless abuse.

As I have pointed out before, Post Keynesianism has some affinities (but also major differences) with the radical subjectivist Austrian economics of Ludwig Lachmann (and Austrians influenced by him like O’Driscoll and Rizzo). You might think that this would be a starting point for building bridges, and O’Driscoll and Rizzo once in fact said so (see The Economics of Time and Ignorance, Oxford, UK, 1985, p. 9). I personally regard ThinkMarkets as the best Austrian blog on the net, miles ahead of the others.

But then I find the ignorant “pop” Austrians – ignorant even of the intellectual diversity of the Austrian school – who do nothing but foam at the mouth at the mention of Keynes’ name.

This ignorance extends to the inability to understand that the debate between Austrians and Keynes and his followers was intense in the 1930s and 1940s, and the Austrians lost that debate. The notion that Keynes was ignorant of Hayek or Austrian ideas is nonsense.

Most of his comments seem right to me, especially his emphasis on the role of uncertainty in modern free market systems. Whitney, however, does not mention the development of Keynes’ work in Post Keynesian economics, the macrotheory which should be mainstream economics.